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IN THE 1990s, Mark Cuban started one of the first internet companies, a video streaming service called Broadcast.com, and later sold it to Yahoo for several billion dollars. With some of the proceeds, he bought the Dallas Mavericks NBA franchise and sold that as well, taking home another several billion dollars.
And for 16 seasons, Cuban appeared on the reality TV show Shark Tank, in which entrepreneurs present ideas to a panel of prospective investors. Surprisingly, though, Cuban acknowledged that the net result of the dozens of investments he’d made on Shark Tank was that he’d lost money. “I’ve gotten beat,” he said.
If investing in startups—often referred to as angel investing—is so challenging, even for someone in Cuban’s position, does it have any merit as an investing strategy? To answer this question, we can first look at the reasons it’s so challenging, and then look at why it might still be worth considering.
Perhaps the most frustrating challenge is that the world of investments isn’t always logical. As an example, Cuban points to Ring, a company that makes doorbell security cameras. In 2013, the company presented on Shark Tank, but Cuban declined to invest, as did all but one of his fellow “sharks.” He thought the valuation was too high, that the company would require too much capital to expand and that competition would make it difficult to succeed. But five years later, Amazon acquired the company for $1 billion.
In Cuban’s view, though, he didn’t make a mistake, arguing that if Amazon hadn’t purchased the company, “they wouldn’t be here.” That’s because, despite its popularity, Ring was losing money. The investment world, in other words, is subject to a lot of randomness. Companies that, on paper, don’t look like they should succeed sometimes turn into successes. And companies that look like they’re doing everything right can sometimes fail. Timing often has a lot to do with it, and that can make angel investing endlessly frustrating.
Another challenge for angel investors: There’s the notion that the ideal startup founder should look like Bill Gates, Michael Dell or Mark Zuckerberg—20 years old and living in a dorm room. For that reason, older founders are sometimes dismissed. But the reality is, older founders, on average, tend to be more successful. According to one study, the ideal age for a founder is 45. But because they’re so well known, founders like Gates, Dell and Zuckerberg contribute to the myth that entrepreneurs need to be young to be successful. This misconception can lead angel investors astray, making them more inclined to invest in founders who might look the part, but who, according to the data, are not as likely to succeed.
Angel investing carries other challenges. Unlike more mature companies, startups tend to be focused on a single product, and that makes them inherently more risky. Startups also tend to be cash-constrained because they don’t have access to public markets, and banks will often lend only with personal guarantees.
In addition, investing in startups frequently requires a great degree of trust. Mark Cuban describes investing in a company that seemed promising at first, “but I’d look at [the founder’s] Instagram, and he’d be in Bora Bora, and two weeks later, he’d be in Vegas, then Necker Island…. Next thing you know, all the money’s gone.” Cuban says he lost $1 million on that investment. While larger public companies certainly aren’t immune to malfeasance, that risk is amplified with smaller companies, where there’s less oversight.
If angel investing is so difficult even for someone as successful as Cuban, what does that mean for everyday investors? In general, I’m an advocate of simple investments, and angel investments are anything but simple. That said, I do see four reasons you might not dismiss it out of hand, despite the steep odds.
1. The first, and perhaps most compelling, reason: Even investments with long odds sometimes succeed. Despite the sobering startup failure rate, there are enough successes to make angel investing attractive.
2. Sometimes an investment makes sense from a relationship perspective. If you know a founder and believe in that person, or simply want to be supportive, sometimes that’s reason enough. In addition, a personal relationship may help mitigate the Bora Bora problem Cuban described.
3. Angel investing can be fun. I remember once, early in my career, making a presentation to a group of prospective investors. They gathered each week at their country club for breakfast and invited a startup company founder to join them. The founder would answer questions while the investors enjoyed their breakfasts. Afterward, the group would spend the morning playing golf together. The reality is that visiting startup companies, hearing their pitches and meeting their founders can be an enjoyable activity. If investment returns are secondary, this may be a valid reason to pursue angel investing.
4. A startup might carry appeal because it’s on a mission to make the world a better place.
If you do choose to make some startup investments, what steps could you take to manage risk? I have two suggestions.
First, diversify. To the extent that diversification is important with standard investments, it’s even more important, in my view, when it comes to private investments. Among professional venture capitalists, there’s a rule of thumb that only one or two out of every 10 investments will turn into a home run. And as Mark Cuban’s experience with Ring illustrates, winners aren’t always easy to predict. So, if you want to make some angel investments, I suggest building a portfolio. Importantly, the idea isn’t to mitigate losses. Rather, when it comes to angel investing, diversification is important so you cast a net wide enough to capture some winners.
Second, to manage the overall risk of making these kinds of investments, I suggest setting a cap on the total you invest. For example, you might allocate up to 10% of your portfolio to non-public investments.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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Sorry but I don’t have respect for Mark C. He may have gotten lucky, ie in the right place at the right time with his first company. But he revelved his true character with the Mavericks. Sitting court side he berated officials and other team players. He was fined many times by the commissioner of the NBA. He behavior was beyond childish. On the TV show, he is one of the least liked sharks for again his childish behavior. Just because you get rich, you may be in the upper class but doesn’t mean you have class. Or maturity…
Adam, you gave 3 good rationales for startup investing and the 4th of potential personal profit. A University academic studying Angel investing told me (somewhat reluctantly) that he thought the total of Angel investing exceeded the payback dollars. Do you have any data to support the opposite?
I joined a startup IT company around age 40. We grew quickly the first few years to around 400 employees and 3 offices. I was a SrVP and saw the good and the bad. I was the one who talked to our bankers every month about our sales forecasts. Like many startups, this company outgrew its 2 initial owners. I left because I did not see any likely changes in leadership. Six months after I left, our venture capital firm brought in a new CEO.
I had no regrets. I got great experience working there five years. I told people I got 15 years experience working there for five years.
It’s funny that you should mention Cuban’s sale of Broadcast.com, because in today’s 24-hour instant news cycle, 1999 is ancient history. Two things always stood out to me about Cuban’s sale of Broadcast.com. First, the deal closed in January or February of 2000. Cuban’s timing of the sale couldn’t have come at a more opportune time, with the Nasdaq as well as the broader stock market topping out less than a month later, in early March 2000, the beginning of a brutal 3-year Bear Market.
But even more memorable and remarkable was how Cuban handled the sale of the company. Rather than reaping the rewards of his Billion Dollar windfall solely for himself, Mark Cuban made sure that EVERY one of the 1,800 employees of the company, right down to the janitor, was made at least a millionaire as part of the deal. Now that’s true LEADERSHIP. A rising tide lifts all boats. Mark Cuban lifted up every one of the Broadcast.com employees that helped make that company a success. Since learning the details of that transaction, I’ve continued to admire not only Mark Cuban’s business acumen, but also his thoughtful leadership.
Because it may take 10-20 investments to fully realize the benefits of diversification (and to find that Unicorn), angel investors may find it beneficial to form investment groups to create more capacity and resources for evaluating investment opportunities.
Great article Adam. Your 4 points remind me of an investment club I belonged to over 30 years ago. We put a percentage of our collective investment in small cap stocks, some almost penny stocks. Some had compelling stories, but they were unable to navigate the startup challenges, like cash flow, supply chain, and business environment. I might expand point 3 to say it can be fun, and very educational. I learned a lot from that experience.
It strikes me that paying for a child’s college education can be a bit like angel investing for some families, and your list a good guide 🙂